Introduction to Securitization

CDO MARKET AND THE HEALTH OF BANKING

CDOs and their impact on the global financial system have been an intensively debated topic of late. U.K. regulator Howard Davies is credited with a statement wherein he equated CDOs with the toxic waste of investment banking. Alan Greenspan, former Chairman of the Board of Governors of the U.S. Federal Reserve Bank during his term in office reiterated on several occasions his unwavering acclaim for CDOs as responsible for maintaining the health of the global banking system. In a speech to the Federal Reserve Bank of Chicago’s 41st Annual Conference on Bank Structure, Chicago, Illinois on May 5, 2005, he stated:

 

As is generally acknowledged, the development of credit derivatives has contributed to the stability of the banking system by allowing banks, especially the largest, systemically important banks, to measure and manage their credit risks more effectively. In particular, the largest banks have found single-name credit default swaps a highly attractive mechanism for reducing exposure concentrations in their loan books while allowing them to meet the needs of their largest corporate customers. But some observers argue that what is good for the banking system may not be good for the financial system as a whole. They are concerned that banks’ efforts to lay off risk using credit derivatives may be creating concentrations of risk outside the banking system that could prove a threat to financial stability. A particular concern has been ...